Capitol One: Keep Track Of Charge-Offs

Capital One Financial (NYSE:COF) just announced that credit card defaults rose to 5.80% in January from 5.78% in December. The charge off rate was not good either rising from 10.14% in December to 10.41% in January. Yet, Capital One and some other lenders in the financial group initially rallied on an analyst upgrade and a “trading call” based on valuation. As the third largest issuer of Visa cards Capital One has a lot of exposure to the consumer credit markets and all the factors that affect it. Though some financial stocks may have “bottomed out” and taken “record charges”, there are still plenty of obstacles in the consumer credit business for Capital One to face.

The key factor in financial distress is unemployment. Unemployment takes time to flow through and impact financial institutions like Capital One. Therefore one should look not only at the unemployment rate but when the jobs were lost. Credit card loans charge off when they are 180 days delinquent (6 months). So today’s charge off is related last year’s job losses. In June through December of 2009 unemployment was in the 9% to 10% range with large initial claims. Many of the people represented in these numbers will default on their credit cards over time. Capital One is sitting on a large potential pipeline of problem consumer loans. Investors should note that during January 2010 credit card accounts that were 30 days delinquent increased, which indicate future charge offs. Credit card problems may not yet have peaked at Capital One.

Financial institutions such as Capital One, Bank of America (NYSE: BAC) and Discover Financial Services (NYSE: DFS) also face a host of problems from the current economic environment. In addition to loan losses financial companies are seeing weak loan demand and have a problem finding quality borrowers. This affects Capital One’s ability to grow and diversify its loan portfolio so that new revenue streams can offset loan charge- offs. The IRS is also taxing debt write-offs that credit card companies have given customers this year, another short-term obstacle for the debt ridden consumer. Then there is the potential problem of rising interest rates on credit cards and mortgages, not to mention more government regulation. Collectively these short and long-term obstacles represent a lot of uncertainty for the consumer loan market.

There may well be financial companies that have low-valuations or might be a good trade. Yet, investors would do well to take a look at the pipeline for potential problems at Capital One, which is large and may be growing.

Steve Gear